If you are thinking of investing in gold or an AIM listed gold mining company, this article aims to give you some background information before making an investment decision.
It explains how the gold market works, how it is regulated, how the quality of gold is assessed and graded. It also covers the various factors that determine price and the ways you can consider investing in gold.
How does the gold market work and how is it regulated?
The gold market is heavily regulated. Gold bars can only enter the market if they are produced by approved refineries such as Johnson Matthey or Heraeus.
The way in which gold is moved from the refiner to the warehouse is also regulated and can only be transported by approved carriers. The market is otherwise closed; there is no other way of getting gold into it.
This guarantees that the gold purity standards are maintained. For instance, if an owner removed gold from the warehouse, they would not be allowed to return it without going through the entire process again.
Once the gold bars enter the warehouse, they are considered eligible for settlement on gold futures contracts traded on the exchange.
However, they only become registered stocks after the warehouse has generated receipts. Not all eligible stocks become registered; often owners just want to house their gold securely in the warehouse.
When gold held in the warehouse is traded, it is the warehouse receipt that changes ownership. Owners can “break” the receipt, taking ownership of the gold metal and moving it from registered status to eligible status.
But if the owner physically removes it from the warehouse, it loses its qualified status.
How is the quality of gold determined and how is it graded?
The quality of gold is determined using various assaying methods. In the past, gold was assayed to determine its purity by first removing a small sample for laboratory analysis, using wet titrimetric methods.
Today, however, that process has mostly been replaced with non-destructive techniques such as X-ray fluorescence (XRF). This uses a focused high energy X-ray beam to ionise gold and impurities.
Electrons are emitted to higher energy levels leaving “holes”. Higher energy electrons fall into these holes emitting photons in the process.
Each transition emits photons at a characteristic wavelength which is captured on a spectrograph and analysed. The purity of gold is usually expressed in karats or fineness:
- Karats are expressed in parts per 24, so 24 karat gold is nominally 100% pure, and 18 karat gold is 18/24 or 75% pure. To determine the purity for any karat simply divide by 24 and multiply by 100.
- Fineness is purity expressed in parts per thousand (PPT). For instance, the finest gold ever produced is 999.999 PPT and is usually referred to as six nines, though it is no longer manufactured.
- Five nines (999.99) is the purest new gold currently available.
- 24 karat gold is three nines (999) while 995 gold is the minimum fineness for “good delivery” gold bars.
- Gold bullion coins such as Sovereigns and Krugerrands are made from 916 (22 karat) gold.
What determines the price of gold?
The price of gold is not directly a function of supply and demand; its value is very much determined by market sentiment.
While additional gold from mines and refineries continues to enter the market, it is only a fraction of total gold in existence. Therefore, supply is always increasing, even if it is at relatively low quantities.
There are many factors driving price but arguably the three most important are:
Economic uncertainty:
When the global economy becomes more unstable and unpredictable, recession becomes a possibility. Investors then see gold as a safe-haven; or a hedge against uncertainty in equity markets. As demand for gold increases so does price.
Inflation:
At times of negative rates of return from conventional asset classes such as bonds, equities and property, gold is considered as an asset that will maintain its value.
Political crises:
When regions of the world conflict, gold is viewed as a portable safe liquid investment.
How to invest in gold?
Many investors consider investing in gold to be a safe haven when global economies encounter economic turbulence. However, while its price is volatile, it does provide a useful hedge as part of a diversified investment portfolio. There are several ways to invest in gold:
(i) Gold metal in the form of gold bullion and coins:
Buying physical gold is an option, but there are some drawbacks. Usually, you will need to pay a premium price from a dealer, so your holding will immediately lose a percentage of its value because of the spread on buying and selling price.
Secure storage of gold by a dealer is expensive but the alternative is storing it at home which brings its own risks.
One positive advantage is that certain coins such as Sovereigns and Kruggerands, minted from 1837 onward, are exempt from capital gains tax.
(ii) Invest in shared gold metal holdings:
This is an alternative way of investing directly in gold. For instance, you can purchase a fraction of a gold bar from the Royal Mint.
(iii) Exchange-Traded Commodity (ETC) :
ETCs can hold gold in a vault, or can invest in gold-related derivatives. Alternatively you can invest in a gold focused Exchanged-Traded Fund (ETF).
(iv) Gold futures contracts which are traded on the exchange:
Essentially these are contracts to deliver an agreed quantity and quality of gold at a specified future date.
(v) Invest in the shares of AIM listed gold miners and producers:
While your investment will give you some exposure to gold markets, the value of your shares will depend on many other factors apart from the price of gold.
What is the role of the World Gold Council?
The World Gold Council is the gold industry’s market development organisation and is involved in all aspects of the gold market, from mining to investment.
The organisation works with governments and other agencies to develop industry gold standards that are recognised globally; for instance, the Conflict-free Gold Standard that aims to close down the link between gold and civil wars.
Mining process
If you want to learn more about gold mining or what gold is used for, then please click on the links.
